September 2011 Archive for Economic Sense

"It is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a 'dismal science.' But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance." - Murray Rothbard Making Economic Sense (1995)

Should we really be thinking about making national tax policies based on the single random anecdotal observation of a celebrity businessman? Recently there has been a lot of talk from the media, politicians, and other commentators about a ‘Buffet Tax’ to ensure that billionaires pay their fair share of taxes. The battle cry comes from comments by very successful businessman and investor Warren Buffet, who claims that his secretary pays more in taxes (as a percent of income) than he does. There are also claims that income for middle Americans has stagnated, while the wealthiest Americans have enjoyed most of the gains in income growth over the last decade. This is a long post, but the short of it is that these claims may sound good politically, and make great headlines for the media, but they don’t stand squarely with the facts.

Let’s look at the first claim. Do billionaires really pay less in taxes as a percent of income than their secretaries?

Since these rates have not changed in the last 5 years, these numbers are still relevant, and show that historically the rich (like Warren Buffet) have always paid more. In fact, when it comes to ‘fairness’, the U.S. has one of the most progressive (meaning the rich pay more) tax systems in the world (see the data here at the Tax Foundation). Sure it is possible that with the correct shelters/loopholes/wealth management, a wealthy person like Buffet could actually end up paying lower overall rates than their secretary. However, what the data shows is that overall, on average, the rich do pay more, with only a few rare and random cases like Buffet paying rates similar to or less than working class Americans. This brings up many questions. Why make major changes in the tax code that will affect millions to address the very few Warren Buffets of the world? Some would say to be ‘fair’ but as noted above, we already lead the world in terms of tax fairness based on income and the rich are already paying more. In terms of all income taxes collected by government, the wealthiest Americans pay most of the taxes.

The top 10% of earners make up about 10% of all households earn about 40% of all income, but pay 55% of all taxes (way more than their proportional share of income). The top 1% of earners make up only about 1% of households, earn about 18% of all income, but pay almost 30% of all taxes, again more than their share of national income.

No matter how you slice the data, there is no way you can claim that the rich are not paying ‘their fair share’ of taxes. (Note this is even after the 2001 & 2003 tax cuts)

Another myth related to this, is that income for middle Americans has stagnated, while the wealthiest Americans have enjoyed most of the gains in income growth over the last decade. Again, this is not supported by the data. The first problem is that commentators and politicians with axes to grind typically refer to the ‘median household income’ to represent ‘middle class.’ While using the median is statistically more robust (less biased) than just the average when it comes to skewed income data, using median household income is still inappropriate. As economists Thomas Sowell and Russ Roberts explain clearly here (video) and here, households have changed tremendously over time, and really aren’t comparable over time. But there are even more reasons why median household income can be misleading. Researcher Steve Conover points out in a recent article at the American Enterprise Institute’s American magazine, just looking at the median to define middle class is a very restrictive definition. After assembling data on income over the last decade based on data from the US Census Bureau and the Bureau of Labor Statistics, Conover developed several definitions of ‘middle class.’ No matter how many different ways we could define ‘middle class’ when we actually look at data on income gains over the last few years, we find in fact that middle class income earners gained much more than the top 20% of earners, while the top 5% actually saw losses.

Source: The Myth of Middle-Class Stagnation, Steve Conover

Of course, if we are concerned about the distribution of income in society, the important thing isn’t so much who’s gaining in which category, but instead it is how often people move up and improve their standard of living. After all, the American dream is not based on how much the rich pay in taxes vs the poor, or who gets the biggest piece of the pie. The American dream is about going out and getting your own piece of pie, or in other words, income mobility. As economist Steve Horowitz explains in this video, even if you insist on looking at ‘median’ income earned by ‘households’ vs. individuals, when we follow these people over time we see lots of income mobility as they move from one part of the income distribution to another. The data shows that income mobility in the U.S. has been very robust. As reported in the U.S. Treasury report Income Mobility in the U.S. from 1996 to 2005:

"Economic growth resulted in rising incomes for most taxpayers over the period from 1996 to 2005. Median incomes of all taxpayers increased by 24 percent after adjusting for inflation. The real incomes of two-thirds of all taxpayers increased over this period. In addition, the median incomes of those initially in the lower income groups increased more than the median incomes of those initially in the higher income groups. The degree of mobility in the overall population and movement out of the bottom quintile in this study are similar to the findings of prior research on income mobility."

So, we’ve debunked the myth that the wealthiest Americans aren’t paying there fair share, we’ve shown that middle class Americans have received significant gains in income over the last decade, and that income mobility in the U.S. is a reality. What other excuses can we/they come up with to raise taxes? One might claim that this is necessary to increase revenues, or reduce the budget deficit. In a previous post I’ve already shown how revenues actually increased while the budget deficit drastically dropped after the Bush tax cuts. Quite a bit of additional research actually shows that higher income individuals are extremely sensitive to tax increases, and that tax increases can contribute to decreased job creation and investment.

Were it not for the recession, the data shows that the middle class and the American dream was thriving. Instead of focusing on class warfare inspired non-issues (at least when it comes to real data), the media, commentators and our law makers should focus on the real issues at hand, chiefly the regulatory climate and the uncertainty (as mentioned last month) that it is creating. Bad government policies, interventons, and regulations created the financial crisis which lead to the recession, and just as in the Great Depression, regulatory uncertainty is currently impeding the turnaround. Besides being based on bad evidence and false perceptions, talk about a ‘Buffet’ tax rule only adds to the cloud of uncertainty keeping us in the current economic rut.